Concerns over oil supply cause spike in prices as uprising hits exports

Chaos in Libya jeopardises global recovery

Sean O'Grady
Friday 25 February 2011 01:00

the price of oil brushed the psychologically significant $120-a-barrel barrier mark during volatile trading yesterday, adding to mounting fears that the world's fragile economic recovery will be choked off by the unrest in the Middle East. Oil started the year at $85 a barrel, and the present panic may have the momentum to carry it beyond the $147 record set in 2008. There was even talk, from analysts at Nomura, of the price passing $200.

The consequences are unpredictable but potentially devastating. For while the peak in prices two years ago arrived gradually and at the end of a long boom, this sudden "political spike", as one market player described it, is far more sudden. As such it will be much more difficult for policy-makers and companies to cope with, especially at a time of stretched national budgets, squeezed living standards and already soaring inflation, especially in food. It could trigger an early rise in interest rates.

The price of Brent crude reached $119.79, the highest in two and a half years, and about $5 up on the start of trading – one of the steepest moves in recent times – on reports that Libya was in danger of losing three-quarters of its output to the uprising. Although Libya supplies only 2 per cent of the world's needs, its high-quality crude is well suited to refining and in high demand in Europe; 8.5 per cent of UK supplies come from there.

Meanwhile, Italy relies for her natural gas supply on a pipeline across the Mediterranean that has now been closed. Oil companies such as ENI of Italy are evacuating their staff, a trend that many fear will spread to the Gulf states and disrupt their oil industries.

As many as 1 million barrels of Libya's daily oil production may have been shut off, Barclays Capital said in a report yesterday. Yet that figure is dwarfed by the 5 million a day of spare capacity that Opec as a whole can call on, and Western stocks are thought to be plentiful. Thus, comments by Saudi officials that they would pump more oil to compensate for the Libyan shortfall pushed the price back to around $111 by close of trading.

The wider fear is that the unrest in Libya, Yemen and Bahrain will spread to much more important exporters. There is also a vestigial risk to shipping through the Suez Canal and Straits of Hormuz. "The big fear is that the unrest will spread to other major producing countries such as Algeria, or God forbid, Saudi Arabia," said Adam Sieminski, chief energy economist at Deutsche Bank.

As with the credit crunch four years ago, when markets routinely assumed the very worst about any bank, so now terrified markets are pricing a complete regional breakdown. Just as the financial markets in 2007 starved the banks of funds and created a self-fulfilling prophecy, so now is the spike in the oil prices threatening to fracture business and consumer confidence, creating harm to the real economy far outweighing the modest interruption in supply.

In the UK, the first effect will be a rapid escalation in the price of petrol and diesel – with the 140p litre coming within weeks. Brian Madderson of RMI Petrol, representing the garage trade, predicts that petrol will cost 132p a litre by next Friday, up from its current record of 129p, and on to 140p or more after 1 April, when the 5p rise in fuel duty is due to be implemented.

More portentously, the crisis places Western governments in an awkward dilemma. The apparent mass movement for democracy now sweeping the region, ousting dictators and offering many people their only taste of freedom after decades of home-grown and colonial oppression, has been welcomed by Western leaders. Yet those very movements threaten the property and economic stability of the West in a way that has not been seen for decades.

The absolutist regimes that the West supported in the region for decades at least offered them reliable energy supplies; but we have always run the risk, and sometimes lived through the violent reality, that "our SOBs" would be deposed or turn rogue, with chaos and damage to Western economic interests quickly ensuing. So it was with Mubarak, for the sake of the Suez Canal and wider peace with Israel; so it is also proving with Gaddafi, whom the US and Britain embraced when he renounced weapons of mass destruction and accepted BP as a partner and the return of Abdelbaset al-Megrahi as a special incentive. These despots follow in a long and sorry line. The Shah of Iran was always a pliable friend of the US, having been installed on the peacock throne by the CIA in 1953. But he wasn't skilful enough to avert the Islamic revolution of 1979 – and the oil crisis that followed precipitated a deep global industrial recession.

We might also recall Saddam Hussein, a useful regional strongman in his day – until he too went rogue and invaded oil-rich Kuwait, another crucial US ally, though no democratic paradise.

The question now is whether Kuwait, the emirates and indeed the House of Saud are going to follow in that long, inglorious line of despotic dominoes. If it did, then no Western power – nor even, for that matter, China – would be strong enough to withstand that oil shock. And that is why the price of oil is so high.

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